Do it yourself

2021 – Market Outlook and Investment Strategy

The 2020th year of Christ is ending on a mixed note. Economically, socially & politically - the environment is filled with a myriad of emotions.

There is hope and anticipation of victory over pandemic and life returning to normal in 2021. Each piece of improvement in the economic data and healthcare statistics brings relief and stokes optimism. The wealth effect created due to higher asset prices is comforting people in more than one ways. The technological advancement and digitalization has made tremendous progress in past 12 months. The global effort towards climate change appears more promising than ever.

There is fear of new variants of Covid-19 virus disrupting the recovery effort and bringing the life to a standstill gain. There is widespread distress caused by the health and economic shock of pandemic. The people in numerous countries are unrestful as they resist increased state surveillance and struggle to manage numerous uncertainties confronting them. A massive leap in socio-economic inequalities is threatening to undermine the poverty alleviation efforts made in past three decades (since end of the cold war, liberation of East Europe, and economic liberalization in India, China & many other populous countries).

There is great deal of uncertainty as to the shape of the global order that would emerge from the shadow of the pandemic. How will Brexit impact the Europe? What would be the impact of a prolonged Sino-US cold war? What will be the end game for the profligate monetary and fiscal policies adopted by most states? How the normalcy will be restored in global monetary system? Will the supremacy of USD be finally challenged? Will neutral currencies (crypto or something else) become universally acceptable, or we will have cold war like trade blocks with their own respective dominating currency (for example, USD & EUR for one block; CNY for another block; and gold for the non-aligned)? Will the international borders closed to check the pandemic ever open fully? How many of the present businesses and industries will become redundant in post Covid-19 era?

In my view, the year 2021 may not provide many answers. To the contrary, as the year progresses, we may be faced with numerous other questions.

Insofar as India is concerned, I feel 2021 may mostly be continuation of 2019, with some added complexities and challenges. The country may continue to witness protests and unrest. People may continue to remain anxious and divided. The consolidation of businesses may continue to progress, with most small and medium sized businesses facing existential challenge. Disintermediation may also continue to gather more pace.

The normal curve for the economy may continue to shift slightly lower, as we recover from the shock of pandemic. A large part of the population may continue to struggle with stagflationary conditions, with nil to negative change in real wages and consistent rise in cost of living. Geopolitical rhetoric may also remain at elevated levels.

The Indian financial markets have faced lot of turbulence in past three years that may not be adequately reflected by the benchmark indices at all-time high levels. In the past 3months returns on investment portfolios may have been promising for most investors. Nonetheless, the confidence level is low and investors are mostly edgy about committing fresh money to financial markets.

With this umbrella view, my outlook for Indian markets is as follows:

Market Outlook - 2021

In my view, the stock market outlook in India, in the short term of one year, is a function of the following factors:

(1)   Macroeconomic environment

(2)   Global markets and flows

(3)   Technical positioning

(4)   Corporate earnings and valuations

(5)   Return profile and prospects for alternative assets like gold, real estate, fixed income etc.

(6)   Greed and fear equilibrium

(7)   Perception about the political establishment

1.   Macroeconomic environment - Negative

My outlook for the likely macroeconomic environment in 2021 is as follows:

(a)   Inflation: The consumer inflation may average around 5%, after the seasonal spike subsides and logistic disruptions get removed. The core inflation may remain weak and ease further during the year as raw material prices ease and wage correction gets over.

(b)   Fiscal Deficit: We may see relaxation in FRBM targets for FY22, as the government continues with the higher social sector spending and revenue lags the target. No significant rise in government investment expenditure may be expected. The systemic liquidity may remain surplus for first quarter of 2021 and gradually return to normalcy in second half.

(c)    Rates: Expect benchmark yields to average below 6% for the year. The next move of RBI would likely be a hike in policy rates. Deposit and lending rates may ease slightly more, before stabilizing or even trending upwards in late second half of the year.

(d)   Current Account: Expect current account balance to stay negative for most part of the year as imports begin to pick up. The deficit may average around 1.5% to 2% for 2021.

(e)    Savings: Household saving may grow at even slower pace as real wage growth remains poor. Aggregate corporate savings though may be higher due to continued deleveraging and rise in free cash flows.

(f)    Investment: The government investment expenditure may remain low due to higher allocation to social sector. Private capex is unlikely to see any meaningful recovery in 2021. Overall, investment growth may see marginal improvement from a low base and government incentives.

(g)    Exchange Rate: USDINR may average close to INR74/USD and move in 73-79 range.

(h)   Growth: Indian may attain higher overall real GDP Growth rate of 11 to 13% in 2020, as benefits of low base, government incentives and policy reforms kick in.

To sum up, the domestic macroeconomic factors may not be materially supportive of stock market in 2021, despite lower rates.

2.   Global markets and flows

Unlike 2020, there is little divergence in the analysts' and economists' views about the global macroeconomic outlook for 2021. The consensus overwhelmingly supports superior growth with emerging markets leading the way.

In my view, the global markets are likely to see higher volatility, as they continue to adjust to the expectations of normalized monetary policies and prolonged period of lower growth. The export based economies of Asia and Latin America will continue to face challenges as demand growth in US and Europe remains slow and Sino-US trade relations remain far from normal. I shall not be worried about any hard landing or financial collapse in global markets, though the situation in Europe does require a closer watch. Expect emerging markets to fare better than their developed peers. Significant yield differential could encourage higher flows into emerging markets in first half of the year.

3.   Technical Positioning

Technically, in my view, the benchmark indices are ripe for a major correction. We may see the volatility spiking in first half of the year as the correction sets in. The second half might see a slow grind down.

Like 2020, Nifty may move in a very large range this year also. On the downside, it may trade in 9365-10140 range. The upside though appears limited to 14117-14700 range. The risk reward balance therefore is clearly negative at present.

4.   Corporate earnings and valuations

The 68%+ gain in benchmark indices during 2017-2020, is mostly a function of PE re-rating; for corporate earnings have shown little growth in this period. Moreover, whatever improvement in earnings is seen, it could be mostly attributed to cost savings (especially financing cost and raw material advantage) and capital reduction (buy backs). There is little evidence of improvement in pricing power or significantly higher productivity of capital. RoEs have in fact declined in past three years.

In my view, the PE re-rating cycle may be mostly over. Any improvement in equity returns from this point onward will have to be driven entirely by earnings growth. The corporate fundamentals would need to show material improvement over next 9-12 months to sustain the present valuation levels.

The current implied earnings growth over FY22 is well over 28%. Even if we can manage this kind of earnings growth (not my base case) due to very low base (almost no growth for over 4yrs now), FY23 could be a challenge. I therefore expect a PE de-rating in CY2022 when the interest rates would begin to normalize.

IT, Insurance, Healthcare and large Realty are the sectors that look positive for 2021. Amongst others, agri input may continue do well as food inflation drives higher spending power in the sector.

5.   Alternative return profile

Real estate: Real estate prices may continue to rise in 2021 as the interest rate and government policies may remain supportive for most part of the year.

Gold: Gold may continue to remain in favor as a strong safe haven asset during 2021. Though the prices may not see material up move.

Fixed income: It is reasonable to expect fix income returns to remain in 5-6% range, as liquidity remains easy and credit demand does not pick up materially. The yield gap that favors equities presently may however not sustain for long in 2021.

Overall, in my view, the return profile of alternatives is neutral for equities.

6.   Greed and fear index

Historically, the most successful, though intuitive, indicator of greed overtaking the fear in market is outperformance of small cap stocks over large cap stocks.

The sharp outperformance of broader markets in 2H2020 indicates that greed has made a strong comeback in Indian markets. There is little to suggest that the sentiments may change in next couple of months. The Greed and Fear balance therefore is unfavorable presently. I expect the broader markets to underperform overall in 2021, with most of the underperformance coming in the later part of the year.

7.   Perception about the political establishment

The recent tendency of aggressively pushing for economic reforms; responding strongly to the geo political challenges; and divergence of Covid-19 cases from global trend has turned the public perception about political establishment favorably. A better show in impending West Bengal and Odisha elections may further improve it. For 2021, therefore  expect the political conditions to remain mostly a positive factor for the markets.

Outlook for Indian markets

In view of the positioning of the above seven key factors, my outlook for the market in 2021 is as follows:

(a)   NIfty 50 may move in a large range of 9365-14700 during 2021. It would be reasonable to expect + 5% return for the year for diversified portfolios. Focused and thematic portfolios could return materially higher yield in 2021.

(b)   The outlook is positive for IT, Insurance, large Realty, healthcare agri input, and consumer staples, and negative for commodities, services and consumer finance. For most other sectors the outlook is neutral.

(c)    Benchmark bond yields may average below 6% for the year.

(f)    Residential real estate prices may show a divergent trend in various geographies, but may generally remain strong. Commercial and retail real estate may also see some recovery.

10 key risks to be monitored for the market in 2021

1.    Relapse of pandemic due to virus mutation or inadequacy of vaccine, leading to a fresh round of mobility restrictions.

2.    Worsening of Sino-US trade relations leading to cold war like conditions.

3.    Material tightening in trade, technology, and/or climate regulations in India and globally.

4.    Hike in effective taxation rate to augment revenue.

5.    Material escalation on northern borders.

6.    Prolonged civil unrest.

7.    Stagflation engulfing the entire economy, as inflation stays elevated and growth fails to meet the expectations.

8.    More exits from EU.

9.    One or more Indian states failing to honor its debt.

10.  Material rise in bank NPAs after forbearance ends.

I do not see hyperinflation as one of the key risks in 2021.

2021 - Strategy

Asset allocation

2021 may be one of the most difficult years for investors, in terms of high volatility, poor expected returns from diversified portfolios and continued low return expectations from cash and debt. In view of this, I shall increase the flexibility of my portfolio. I shall keep 30% of my portfolio as floating, while maintaining an UW stance of equity and debt.

Large floating allocation implies that I shall be trading actively in equity.

(a)   The fixed equity allocation would be 40% against 60% standard.

(b)   The fixed debt investment would be 20% against 30% standard.

(c)    I would park 10% in cash/money market funds.

(d)   30% of portfolio would be used for active trading in equities and debt instruments.

My target return for overall financial asset portfolio for 2019 would be ~8%.

Equity investment strategy

I would continue to focus on a mix of large and mid cap stocks. The criteria for large cap stocks would be growth in earnings; while for midcaps it will be mix of solvency & profitability ratios and operating leverage.

(a)   Target 6% price appreciation from my equity portfolio;

(b)   I shall be overweight on IT, Insurance, Healthcare, Agri input and large Realty stocks.

(c)    For trading I will focus on large cap liquid stocks.

Miscellaneous

I have assumed a relatively stable INR (Average around INR74/USD) and slightly higher short term rates in investment decisions. Any change in these assumptions may lead to change in strategy midway.

I would have preferred to invest in Bitcoin, but I am not considering it in my investment strategy due to inconvenience and unease of investing.

Factor that may require urgent change in strategy

·         Material rise in inflation

·         Material change in lending rates

 A literal interpretation of the latest statistics would indicate that Indian economy is passing through a recession and faces a specter of stagflation. A young demography like India can certainly not afford this condition.

The government officials have termed the recession as a “technical” one, induced temporarily by the total lockdown imposed in the wake of the outbreak of Covid-19 pandemic. The economic managers of the government have also vehemently denied any possibility of Indian economy slipping into a stagflationary trap.

In my view, however, this entire discussion based on official statistics might be “technical” in nature. Wandering through the streets of large cities and fields in the hinterlands over past few months, and interacting with people from various strata of the society, I am convinced that more than two third of Indian population may already be trapped in the stagflationary conditions, with their real income stagnant or declining over past few years and essential expenses rising. The economic and health shock of pandemic may have only accelerated the trend of deterioration.

Another noteworthy thing in the official narrative is that an attempt is being made to establish as desirable base for the future growth paradigm. This sounds unfortunate, as the pre March 2020 situation was worrisome and far from desirable state of economic growth. Therefore, in my view this “V shape recovery to pre March 2020 level” narrative is also ironical and redundant.

Nonetheless, as we approach end of calendar year 2020, it is useful to look at the latest economic trends; draw estimates for the next year and see if any changes are required in the investment strategy and investment portfolio.

I find the following economic trend worth noting. I shall continue to keep a close watch on these trends for my investment strategy purposes.

1.    The long term growth trend (5yr CAGR of Real GDP) of India’s GDP peaked in FY08 and has been declining since then. Even normalized for the sharp deceleration in pandemic affected FY21, the long term growth shall remain below 6% for next 3years at least. Success of recent stimulus program for promoting manufacturing and agriculture growth may add 50 to 75bps to India GDP by FY23. Even then the long term growth trajectory shall remain below the 9% rate desired to create enough employment for the fast increasing workforce of India.

2.    India’s savings rate, especially household savings rate, has been declining consistently for past 10years. On the other hand, the household indebtedness is on the rise. Historically, the domestic savings have supported both the public finances and private investments. Lower savings is making the growth and social sector spending more dependent on foreign capital. Nothing inherently wrong in borrowing from overseas; but it increases the external vulnerability, especially in the periods of crisis. The global monetary conditions indicate that the crisis may be more “norm” than “exceptions” in next decade. Obviously, a further deterioration in domestic savings will make us more vulnerable to global volatility.

3.    The export growth of India has been dismal in past decade. The stagnating exports in fact have been one of the primary factor behind declining growth trend in India. The government has apparently taken cognizance of this fact and taken a slew of measures to promote exports. I shall be keenly watching if these measures result in meaningful and sustainable acceleration in exports, especially manufactured exports, from India.

4.    After peaking in 2018, the non-performing assets in the Indian financial systems had shown encouraging trend in past two years. I shall be keenly watching the trend in NPA, once the relaxations given as part of support to businesses in post lockdown period end next year. A sharp rise in NPA level again would seriously impact the mid term growth prospects of the economy.

5.    The household and corporate investment in fixed assets has deteriorated in past decade. If the prevalent low interest rates fail to revive the investments in next couple of years, the mid-term growth potential of Indian economy could be seriously impacted. I shall be watching the revival of investment, which most analysts are expecting to happen in 2021.

6.    The real rates have remained negative for past many months now. It is estimated that the policy rates may have bottomed, and remain at present levels for most of 2021. This shall keep the real rates negative for 2021 also. I shall watch for any violation of this premise. The real rates turning positive may trigger a rise in short term rate and reallocation of assets.

7.    The tax collections have seen sharp decline in FY21. If the normalcy in tax collections is not restored in 2021, we shall see (i) material decline in government expenditure 9which has supported the growth revival so far); (ii) rise in effective tax rate; or (iii) both.

8.    Excess liquidity in the financial system has made the policy rates redundant in the near term. This situation cannot last for longer. Unless we see sharp acceleration in credit demand, RBI may be forced to change its “accommodative” policy stance. This may be negative for equities in the short term.

The year 2020 has been a period of extremes for markets. During past 12months, the equity markets have kept swinging between extreme fear and greed. The year began on a buoyant note. The benchmark indices scaled their all-time high levels on 24 January, after rallying for past 4 months. In the following 2 months the indices corrected ~40% from their January highs, refreshing the fading memories of 2008 crash. A sustained rally thereafter saw the benchmark indices scaling new highs in next 9 months. This rally was remarkably different from September 2019-January 2020 rally in terms of volumes, market breadth, and participation. Foreign investors and domestic household investor have been notable buyers in 2020 rally, while the domestic institutions have been net sellers.

In my view the top 10 highlights of the performance of Indian equities in 2020 were as follows:

1.    Though benchmark indices indicate that mid and small cap indices have done materially better than the benchmark Nifty; the market breadth has not been encouraging. Relatively less represented sectors IT and Pharma outperformed strongly, while the most represented financials and energy were massive underperformers.

2.    Market breadth was positive only for 5months, while in seven months market breadth was negative. March 2020 was the worst month and August 2020 was the best month in terms of market breadth.

3.    Indian equities were average performers, in comparison to the global peers. However, it underperformed its emerging market peers notably.

4.    A lot of discussion has taken place around the strong foreign flows into Indian equities. It is however worth noting that foreign investors have invested close to Rs48,000 crores in Indian equities during 2020. But most of this has come as switch from the Indian debt. The net foreign flows to India in 2020 are marginally negative.

5.    The long term Nifty return (5yr CAGR) is now consistent around 11-12% for past five year. Only 2019 was an exception with 8% long term return. This is the longest stretch of consistent returns. This highlights the maturity of Indian markets; and also lesser probability of exceptional gains in near future.

6.    Nifty averaged around 10985 in the year 2020. This is about 4% lower than 2019 average. During previous two crisis periods (2001-2002 and 20008-2009), the fall in yearly average traded value of Nifty lasted for two consecutive years. But the third year saw strong recovery in the average traded value. If the history repeats, the Nifty may average below 10985 in 2021.

7.    The market saw sharp rise in speculative trading activities during the year. The percentage of total shares traded to the shares delivered fell from 20.5% in March to 15.05% in June. However, it has again improved to 19.6% in November.

The net new money invested in equity trades (NSE net pay in) was highest in March 2020 when the market correctly sharply; implying that the first fall bought aggressively. May-June also witnessed higher new money.

The size of average trade increased to Rs32462 in November 2020 from the low of Rs22314 in March 2020; implying that the smaller investors are now less active in the market.

8.    After losing ~30% in 1Q2020; Nifty gained ~20% in 2Q2020; ~9% in 3Q2020 and ~20% in 4Q2020. The gains in last three quarters have come without any correction. Only the month of May2020 has yielded negative return of (-)2.8% since April 2020.

9.    Despite the crises and sharp correction in the market early in the year, the volatility has not spiked like the previous two crisis periods. Consequently, the arbitrage funds have sharply underperformed, yielding less than the liquid fund returns. Gold ETFs outperformed most of the equity fund categories.

10.  The Nifty earnings have seen a spate of upgrades in recent weeks. However, normalized for the base effect of FY21, the growth continues to remain anemic. Most of the appreciation in equity prices therefore could be purely due to PE rerating to factor in lower interest rates. This implies, interest is perhaps the single most critical factor to watch in 2021. Any sign of hike in rates could result in sharp correction in equity prices.

 The two thousand twentieth year of Christ is coming to an end. This year has been totally forgettable and remarkably transforming at the same time. It reminds me of the title of the autobiography of legendry poet Dr. Harivansh Rai Bachachan – “क्या भूलूँ, क्या याद करूँ”.

Notwithstanding the all-time high levels of stock market indices in most countries; the global financial system inundated with trillions of dollars in free liquidity; over US$20trn worth of bonds yielding negative return globally; the massive economic and social shock of Covid-19 pandemic has left billions of people in distress. The inequalities of income, wealth and opportunities have risen to new highs.

Significant developments have been reported on the front of vaccine development to check the spread of Covid-19 virus. Many countries have already authorized emergency use of some vaccines; and people are being administered such authorized vaccines. Nonetheless, recently a fresh wave of mutated version of Covid-19 virus has been reported from some places in Europe (especially UK), resulting in fresh set of mobility restrictions. This indicates towards the possibility that the world may not return to total normalcy in many months to come. As per various estimates, it will take 15-18months to inoculate a sizeable population to reach a stage of herd immunity against the Covid-19 virus.

On the positive side, the pandemic has accelerated many trends that may help the cause of sustainable faster development in the medium to long term.

There have been many events in 2020 that must be taken note of by the investors. However, as a tine investor in Indian assets, I would in particular like to remember the following eight for next many years.

1.    The Indian government imposed a total socio-economic lockdown in the country in the wake of the outbreak of pandemic from 25^th March 2020. The restrictions were relaxed gradually from June onward.

In my view, it is almost impossible to assess the utility and true impact of lockdown exercise. We would never know, what could have been the situation if a total lockdown was not imposed in March. It could have been worse in terms of economic and health shocks; or perhaps the economic loss could have been less pronounced, sans total lock down.

This episode however has further strengthened my already strong view that the incumbent government is unpredictable. It can take decisions having far reaching repercussions rather quickly; without adequate planning; and without bothering about the immediate consequences in terms of human suffering. I shall continue to incorporate this feature in my investment strategy for midterm.

2.    During the lockdown, when the human activities and mobility were restricted to a great deal globally, the nature attempted to reclaim its space. The instances of peacock dancing on city streets, deer, sheep and even lions roaming freely on public roads, air quality improving to “serene” from “severe”; visibility improving to few hundred kilometers from few meters; children learning that the color of sky is “azure” and not “pigeon blue”. However, within 15 days of unlocking, the human reclaimed the entire territory from the nature.

Notwithstanding the enthusiasm behind sharing pictures of “pure nature” on social media, it is clear that we have moved too far on the path of self-destruction.

On the other hand, “work from home” and “digital meetings” have been adopted as fait accompli by many businesses. This because it brings immediate tangible benefits to both, the employer and the employee.

This leads me to conclude that any global agreement on climate will not succeed unless it has immediate and tangible economic payoff for the parties. The Paris accord, fails on this test, just like the Kyoto protocol. I shall therefore not be looking for investment opportunities in Paris accord, unless I see tangible economic gains for Indian businesses and consumers.

3.    On 20^th April 2020, something happened in global commodities market, which was unheard of. The WTI Crude Oil Future in New York crashed to a negative US$37.63 price. This event, though rare, has added a new dimension to the risk management process; option pricing methods; and trading strategies.

4.    The benchmark crypto currency “Bitcoin” has been vogue since 2009. Even though it was accepted as a medium of exchange in many jurisdictions, it never gained wider acceptance as legitimate asset like gold or store of value like currency. In 2020, most of the reputable global investors and strategists have accepted Bitcoin as futuristic “store of value”, just like gold and USD. This acceptance has come on the back of Bitcoin’s sharp outperformance vs precious metals and USD. I believe that this marks the beginning of a new era on global monetary system. Neutral digital currencies shall continue to gain prominence in global monetary system in future. May be this prominence would diminish the dominance popularity of gold and USD as global reserve currencies.

5.    The year saw a brilliant thaw between the traditional enemies the Arabs and the Israelis. Some strategic initiatives were taken by Israel, UAE and Saudi governments to reduce tension in the region. This also saw Arabs increasing distance from Pakistan. I see this as a good omen. It may result in sustainable reduction in terror support and funding globally. However, this has pushed Pakistan closer to China. The tension at Indian northern, western and eastern borders may sustain and even increase in short term. More frequent hostilities at borders  is something we would need to incorporate in our investment strategies.

6.    Reliance Industries, led by Mr. Mukesh Ambani managed to convince global business leaders like Facebook and Amazon, and investors like KKR, Carlyle, GIC, ADIA etc to invest in its digital and retail ventures. Global petroleum majors British Petroleum and Aramco have also committed large investments in fuel business of the company. If these investments are consummated successfully in next 2-3years, we shall see many large Indian businesses gaining attention of the global business leaders and investors. I shall be reevaluating some of the large, viable but heavily indebted businesses from this viewpoint.

7.    First protests against the Citizenship Amendment Act (CAA and Shaheen Bagh) and now protests against the three acts to reform the farm sector in the country have further strengthened my belief that the mistrust between the ruling BJP and opposition parties has breached the red line. The political environment shall get further vicious, once the BJP tries to conquer the Forts of East (West Bengal and Odisha) next year. I shall not be expecting political consensus on any issue for next few years, for my investment strategy. Although with Congress weakening further, getting majority votes in Rajya Sabha may not be an issue for the government, nonetheless, the threat of reversal of contentious legislative changes shall always prevail, should a united opposition manage to dethrone BJP in 2024. (I agree that as of this morning this looks almost improbable).

8.    India recorded its first recession in past four decades in 2020. Though many analysts are terming it a technical recession due to lockdown; I would like to wait and see the trajectory of recovery to conclude if a lasting damage has been caused to the growth prospects.

In the recent Global Competitiveness Report, the World Economic Forum examined how different countries are traversing on the road to recovery from the health and economic shock of Covid-19 pandemic, which “impacted the livelihoods of millions of households, disrupted business activities, and exposed the fault lines in today’s social protection and healthcare systems”. On the positive side, the shock is believed to have accelerated “Fourth Industrial Revolution on trade, skills, digitization, competition and employment”.

There is large section of observers who reject World Economic Forum in general and its research in particular, as mostly elitist and prejudiced against developing economies. I do not have any strong objection to the views of this section of people. However, I do occasionally study the work done under the aegis of WEF and find it useful for identifying the problem areas and directions for further study. I read the Global Competitiveness Report 2020 also with this perspective. The following are some of the points that I find mostly incontrovertible and useful in making a reasonable assessment of the present situation.

·         Before pandemic high levels of debt in selected economies as well as widening inequalities was a major area of concern. The emergency and stimulus measures have pushed already high public debt to unprecedented levels, while tax bases have continued eroding or shifting. Now, the priority should be on preparing support measures for highly indebted low-income countries and plan for future public debt deleveraging. In the longer run (transformation phase) countries should focus on shifting to more progressive taxation, rethinking how corporations, wealth and labour are taxed.

·         The COVID-19 crisis has accelerated digitalization in advanced economies and made catching up more difficult for countries or regions that were lagging even before the crisis. In the revival phase, countries should upgrade utilities and other infrastructure as well as closing the digital divide within and across countries for both firms and households.

·         Skills mismatches, talent shortages and increasing misalignment between incentives and rewards for workers had been a major problem for advancing productivity, prosperity and inclusion for many decades. The focus should now turn to new labour market opportunities, scaling up reskilling and upskilling programmes and rethinking active labour market policies. The leaders should work to update education curricula and expand investment in the skills needed for jobs in “markets of tomorrow”.

·         The pandemic has highlighted how healthcare systems’ capacity has lagged behind increasing populations in the developing world and ageing populations in the developed world. Now, the health system capacity needs to be expanded to manage the dual burden of current pandemic and future healthcare needs. Especially, there should be an effort to expand eldercare, childcare and healthcare infrastructure and innovation.

·         Over the past decade, while financial systems have become sounder compared to the pre-financial crisis situation, they continued to display some fragility, including increased corporate debt risks and liquidity mismatches. The countries now prioritize reinforcing financial markets stability, while starting to introduce financial incentives for companies to engage in sustainable and inclusive investments.

·         Pre-crisis, there was increasing market concentration, with large productivity and profitability gaps between the top companies in each sector and all others; and the fallout from the pandemic and associated recession is likely to exacerbate these trends. In the revival phase, therefore, the effort should be to strike a balance between continuing measures to support firms and prevent excessive industry consolidation with sufficient flexibility to avoid keeping “zombie firms” in the system.

·         Post global financial crisis, a trend was seen emerging against globalization. In revival strategies, countries should lay the foundations for better balancing the international movement of goods and people with local prosperity and strategic local resilience in supply chains.

It is emphasized that “The global economic outlook for 2021 is highly dependent both on the evolution of the pandemic and on the effectiveness of the recovery strategies of governments”. It is critical to assimilate that the governments across the globe have deployed US$12trn to support households and businesses with emergency income and cash flows. This support shall begin to expire as the process of “unlocking” progresses. The recent economic recovery with the support of these support measures may not be a guidepost for the future economic trends. “Instead, the road towards economic recovery will be long, asymmetric and asynchronous across different economies”.

Where does India stand on the road to recovery?

1.    Amongst G-20 countries, India is a dismal and distant last in terms of percentage change in the skills of graduates during 2016-2020. Suadi Arab, China and South Korea share the podium positions in this area.

2.    India with 9.5% NPA level (2018 data) has the lowest score of soundness of banks amongst selected countries and ranks at the bottom (only better than South Africa) in terms of finance access to SME.

3.    India is placed close to the bottom in terms of share of global patent applications.

4.    Global business leaders see no significant improvement in the globalization of India’s value chain in future.

5.    India ranks much below the global average on workforce upgrade (law and social protection), investment in of skills and upgrading education curricula, digital access, rethink on competition and antitrust framework, creating markets of tomorrow, investment in R&D and innovation, diversity & inclusion,

6.    India is placed in the 9^th declie (bottom 20%) in terms of readiness for economic transformation post pandemic.

In view this gives a fair idea of areas where we are lacking and need to work hard. As an investor, this also allows me to upgrade my matrix of key factors that I focus on for identifying major risks and opportunities.

 The benchmark indices are scaling new highs every week for past seven weeks as least. The sharp recovery in markets, from deep correction in March, must have surprised most market participants. Many who panicked and sold off in summer are wondering whether it’s time to “Buy” again. Many who remained invested are wondering whether it’s time to ‘Sell”.

The broader question therefore seems to be, whether we are in a new bull market since April 2020, and the stock prices have a long way to travel north before any meaningful correction sets in; or it is a bear market rally that is normalizing the steep fall in March 2020 in the wake of total lockdown announced post outbreak of pandemic.

The last bull market started from August 2013 and lasted 5yrs till August 2018. In case we believe that it is new bull market that would mean that the bear market that started in August 2018 ended with panic bottom of March 2020.

However, if we believe that March 2020 panic fall was an aberration and the current sharp up move is just normalizing that aberration, and the regular bear market will play out after this normalizing cycle is completed in next couple of months. In this case we shall see markets stabilize around in 11500-12100 range and then decline gradually for some time. We had seen a similar situation in 2006-2009. In May 2006, markets corrected 25% in 3weeks as the first signs of subprime crisis emerged. But then markets rallied almost 100% (from lows of June 2006) in June 2006-January 2008 period; only to bottom around June 2006 levels in March 2009.

The moot point is how do we decide what state the stock market is in at present! The signals from the markets are indicating that regardless of the one way move in the market, the popular opinion is divided.

For example, the following are some signs indicate to a bull market:

(a)   Many IPOs since March 2020 have got tremendous response from investors.

(b)   Analysts are either ignoring bad news or finding positive angles in bad news . For example, consider the following:

·         One of the key argument for support of consumption related stock was the government support to the rural population. However, the news of PM-Kissan disbursement not happening (see here) was given a positive twist to imply that fiscal situation may not worsen after all.

·         M&M subsidiary SsangYong default on debt was given a positive twist to imply that M&M is sticking to its commitment of not investing more capital in loss making subsidiary.

·         Despite concerns over rising defaults on unsecured loans after the forbearance period ends, the valuations of many consumer focused NBFCs have breached the red lines. Analysts are supporting these valuations in the name of business consolidation, potential bank licenses etc.

·        S&P forecast of 7.7% contraction in India’s FY21 GDP was widely reported as “upgrade”.

 

(c)    All sellers are seen regretting almost immediately after the trade, as prices rise further before the payout is received.

(d)   Traders, investors and even fund managers are searching for stocks that have underperformed the peers, and betting new money on them in the name of “value”.

(e)    The social media timelines are overwhelmingly populated with success stories of popular traders and investors. The cautious investors are being guilt shamed by taunts of “I told you so”; and “I bought xyz in March 2020 and made return of $$$% in 9months”.

On the other hand, the following signs point to the possibility that it is a bear market rally that is normalizing the excesses of March 2020.

(a)   There is no particular theme or trend in the recent rally in stock prices. Stocks from diverse sectors like Bajaj Finance and Kotak Banks have become most expensive stocks perhaps globally, while ICICI Bank and HDFC Bank have lagged. Tata Steel has reached peak valuation while Hindalco has lagged. Tech Mahindra has ralled hard, while Infosys and TCS have lagged. Asian Paint has outperformed HUL massively. RIL has outperformed Bharti.

(b)   Domestic mutual funds have faced redemption in past couple of months. Domestic institutions have been net sellers so far this year, while foreign institutions have been net buyers.  However, there is no clear pattern in the flows, indicating tentativeness and lack of conviction. Overall net institutional flows have been marginal ($3.5bn) YTD.

(c)    Most of the rise in market has occurred due to valuation rating and not supported by earnings or forecast of earnings growth.

 

(d)   Last week the top gainer in NSE500 included some companies facing survival issues.

Personally, I am more inclined towards the second view (bear market rally). But I would leave it to readers to apply their own wisdom and decided their strategy.

 

 In a recent note, Matthew Hombach, Chief Rates Strategist of Morgan Stanley, wrote that Central Banks will inject another $2.8trn of liquidity in the global financial system in 2021. This would be the double the amount of highest liquidity injection in any year prior to 2020. This abundant liquidity, in Matthew’s view, will support the riskier investments at the expense of investments entailing lesser risk; implying weaker USD and US Treasuries and Stronger EM currencies and Equities. The caveat however is “if central banks signal a reduction in liquidity earlier than we expect, or our economists’ buoyant expectations aren’t met, risky assets could experience a wobble, a theme that might very well feature in our 2021 mid-year outlook”.

The conventional theory is that as the supply of transactional currency (money) rises, the price of money (interest rate) decreases. The lower interest rate results in lower cost of owning and carrying assets resulting in higher demand, and therefore higher price, for assets. Lower cost of money is also traditionally believed to increase the risk taking ability of the borrowers, resulting in higher demand for riskier assets, e.g., equities (over debt), emerging market assets (over developed market assets) etc. Lower cost of money is also seen to be catalyzing the flow of savings (surplus liquidity) from low yielding assets (e.g., USD, JPY, developed countries’ bonds etc.) to high yielding assets (e.g., emerging market currencies & bonds).

Also, as per conventional theory, the rise in supply of money which is not matched by rise in production of goods and services, inevitably results in rise in prices of goods and services (inflation).

However, the market trend seems to have strongly defied these conventional theories in past 10 years. Ever since the global central banks adopted the new normal monetary policies of abundant liquidity and near zero to negative interest rates, the demand and prices for developed market assets (USD, Developed market bonds and equities etc) have mostly outperformed the emerging markets and the prices of physical commodities have remained low, notwithstanding the small bump in recent months.

I think, the investment strategy needs to assimilate the trends in monetary policy, asset prices and inflation (of goods and services) in a holistic manner rather than drawing conclusion from the bits and pieces. The economic and financial research may better focus on the issue whether—

(a)   The excess (or additional) money printed in since the internet revolution started in late 1990s is to adjust the stock of money for rise in productivity, dematerialization, colossal rise in income and wealth inequalities and consequent changes in consumption, trading and investment patterns, changes in velocity of money etc.; or

(b)   The conventional theories are still valid and we are just protracting the inevitable, i.e., hyperinflation in prices of goods and service